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Is Aussie Dollar ETF in Trouble?

Zacks Equity Research

The Australian economy which has enjoyed steady growth over two decades has lately been witnessing a slump. Commodity abundance was the one of major driving forces of Australia – especially the base metals and energy product – that assisted the nation to dodge recession during the global financial meltdown.

However, slowdown in China, a major importer of Australian natural resources, falling prices of iron ore – Australia’s largest export,  faltering consumer confidence thanks to government spending cuts and new tax burden in a 2014/15 federal budget have lately affected the nation’s growth.

To refuse to give in to such obstacles, the Australian central bank slashed key interest rates by 2.25 percentage points to a record-low 2.5% from late 2011 through August 2013 (read: Australian Dollar ETF Falls on Rate Cut). The central bank has decided to keep the rate at a low level in the coming months given the soft Australian growth rate in 2013.

This step coupled with continuous trimming of QE policy in the U.S. is weighing on Aussie dollar. With Goldman Sachs and other investment banks still hoping for more rate cuts (according to the Morning Herald), Aussie dollar might weaken further in the coming days.

Another reason that will likely push the Australian dollar down, as per the Bank of Australia deputy governor, is shift of the mining industry from an investment phase to a stage of increased output.

This will result in lower foreign capital inflow and depreciation in currency. Sluggish iron ore prices were also hindrances to the Aussie dollar. Iron-ore prices recently slipped below the psychological level which could put pressure on the currency. 

Though the Australian dollar has been a winner this year gaining about 4%, the journey ahead might not be that smooth. As per Trading Economics, the currency is forecast to slip 0.89 AUD/USD in Q2 from 0.92 which was the average exchange rate in Q1.

The exchange rate is expected to fall to 0.85 AUD/USD in 2015 thanks to the compounding effect of a weakening Aussie dollar and strengthening U.S. dollar.

ETF Impact

The impact should be felt in the currency world as well. We presently have a Sell recommendation on the CurrencyShares Australian Dollar Trust ETF (FXA). The Australian Dollar ETF tracks the relative movement of the AUD relative to the USD.

The funds in this product are denominated in AUD and kept in a bank account, and the interest thus received is used to pay for the expenses and fees of the fund. The fund looks to generate returns through the bank interest and any capital appreciation that may occur on account of AUD appreciating versus the USD. Last week, FXA lost around 1.36%.

Investors, who are bearish on the Aussie dollar right now, definitely for a valid reason, may consider a near-term short on the space. Below, we highlighted an option in the inverse ETF space through which investors can make some profits.

This ETF – the UltraShort Australian Dollar ETF (CROC) – makes a profit when the Aussie dollar declines and is suitable for hedging purposes against the fall in the currency. CROC seeks to deliver twice the opposite of the daily performance of the U.S. dollar price of the Australian dollar. The fund charges 95 bps in fees. CROC added about 2.63% last week (read: ProShares Launches Leveraged Australian Dollar ETFs).

Bottom line

If the Fed remains determined to fully wrap-up the QE program by this year end in the wake of positive economic indicators, the U.S. market will see an uptrend in the greenback. And in the absence of cheap-dollar inflows, investors will be less likely to invest in risky assets like Australian dollar. As discussed above, monetary policy in Australia is also not in favor of boosting the currency’s appeal (read: Where Will Global Currency ETFs Go in 2014?).

Given this, investors can ignore the Aussie dollar at the current level or book profits out of some inverse products. However, investors should note that the aforementioned inverse leveraged product – CROC – should only be considered for very short-term trading purposes.

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Read the analyst report on CROC

Zacks Investment Research

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